Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Gem-Year Industrial Co.,Ltd. (SHSE:601002) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Gem-Year IndustrialLtd's Debt?

As you can see below, Gem-Year IndustrialLtd had CN¥70.7m of debt at June 2024, down from CN¥181.5m a year prior. However, its balance sheet shows it holds CN¥379.1m in cash, so it actually has CN¥308.4m net cash.

A Look At Gem-Year IndustrialLtd's Liabilities

We can see from the most recent balance sheet that Gem-Year IndustrialLtd had liabilities of CN¥982.2m falling due within a year, and liabilities of CN¥99.5m due beyond that. Offsetting these obligations, it had cash of CN¥379.1m as well as receivables valued at CN¥845.9m due within 12 months. So it actually has CN¥143.3m more liquid assets than total liabilities.

This surplus suggests that Gem-Year IndustrialLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Gem-Year IndustrialLtd boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Gem-Year IndustrialLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Gem-Year IndustrialLtd made a loss at the EBIT level, and saw its revenue drop to CN¥2.2b, which is a fall of 3.0%. We would much prefer see growth.

So How Risky Is Gem-Year IndustrialLtd?

Although Gem-Year IndustrialLtd had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CN¥239m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Gem-Year IndustrialLtd is showing 2 warning signs in our investment analysis , and 1 of those is concerning...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.